Recently, a mom in one of my social media groups submitted a post asking for advice about the best musical instrument for her children to learn. I posted a reply saying that there is no one best instrument, but rather, the instrument must meet child's interests and needs.

Today, a rite of passage for many fourth graders it to choose a musical instrument to play. Children learn about three major instrument groups – strings, brass, and woodwinds, each of which has within it several options suitable for elementary school students, including violin, viola, and cello for the string instruments, trumpet, trombone, and baritone for the brass instruments, and flute, clarinet, and perhaps, saxophone, in the woodwinds.

Each group of instruments and each instrument, itself, has benefits and detriments. In the end, the decision should be made by finding the instrument which provides the best fit for the student and his/her physique and of course, interest. For instance, it can be difficult for a child to play certain wind instruments unless he or she has a certain number of adult teeth. And, although string instruments now come in a variety of sizes, most wind instruments do not, making the larger instruments, such as trombone and baritone, unwieldy for a small child.[1]

Likewise, the student’s goals should be considered when selecting the instrument. Cello would not be a good choice for a child who wants to play in the high school marching band, and saxophone or trumpet would be better choices than flute or baritone for a child who wants to play in jazz band.

New business owners face a similar dilemma in selecting the type of structure to use when forming the business.  There are four main business structures:

1. Sole proprietorship, a business which has a single owner and has not formed a business entity;
2. Partnership, a business which has more than one owner and has not formed a business entity.  The partnership may or may not have a written partnership agreement. For instance, two spouses who form a business together usually are a partnership, even if they do not enter into a partnership agreement;
3. Limited Liability Company (LLC), which can have any number of owners and is formed by filing paperwork with the state. Limited liability companies; and
4. Corporation, which also can have any number of owners and is formed by filing paperwork with the state. Corporations must have boards of directors and officers, so they usually operate more formally than limited liability companies; although that does not have to be the case.

As with musical instruments, there are options within each group.  For corporations, there is the decision whether to be taxed as a C corporation or an S corporation.[2]  For partnerships, there are general partnerships and limited partnerships.  Finally, limited liability companies, there can be member-managed or manager-managed LLCs, and there is the possibility of electing to tax an LLC as if it were a corporation.  Further, there are decisions to be made about owner rights, including whether there will be both preferred and common equity, who will make major decisions, buy-sell rights, and how profits and losses will be allocated.

Important factors in deciding which of the four primary structures include:

A. Who the Business Owner Expects to Be the Current and Future Members and How Involved They Will Be In the Business Operations.  Although any business structure can accommodate owners who all are actively involved in the business, a corporation or limited liability company may work best where many of the owners are investors who will not be involved in the daily business operations. 

B. Desire for Protection from Personal Liability for Business Obligations. Owners of a sole proprietorship or partnership have full, personal liability for all business obligations.  Owners of a limited liability company or corporation generally will have liability for business obligations beyond their capital contributions only if they sign personal guarantees. Liability protection is a major reason why small business may choose to operate as a limited liability company or corporation.

C. Tax Issues.  With a sole proprietorship or partnership, the owners usually can expect to pay income taxes at the regular rates on all business income. Further, if structured as a sole proprietor or single member limited liability company, the owners actively work for the business, and he or she may have to pay self-employment taxes on all of the business income. 

Limited liability companies with multiple members and partnerships usually will be taxed as partnerships.  If so, owners can expect to pay income taxes at the regular rates on all business income, but they might be able to structure the payments from the business so that they do not pay self-employment taxes on all of their income. 

Although owners of corporations can arrange to receive part of their money as dividends so that they do not pay FICA on it, such dividends will still be subject to what is known as “double taxation.”  This means that the corporation pays taxes on the income, and then, the owners will pay taxes on the same income again when they receive it from the corporation as dividends.  This is why many corporations make what is known as a “Subchapter S election” to become S corporations, which results in the tax structure looking more like a partnership.  However, there are limitations on who can own shares of an S corporation.  

Finally, on the tax issue, in the Tax Cut and Jobs Act passed in December 2017, there is the potential for a 20% deduction for businesses that operate as pass-throughs (which generally is anything except a corporation which is not an S corporation), which can provide a significant tax savings for some businesses. I discussed this in my previous blog, "A String Quartet, a Nothing Special Diner, and a Famous Chef Diner take a Random Walk through the New Section 199A Pass-Through Deduction."

Although it may cost some money up front, this is a complicated area, and everyone considering forming a business should consult with a business attorney and the accountant who will handle the business’ accounting before setting up the business structure.  That is the best way for a business owner to assure that the structure will meet both the business’ current and future needs.

[1] Pitch for a string depends on a relationship between string length and thickness.  However, on a wind instrument, any particular note requires a certain length  column of air which can’t be changed. That is why child-sized string instruments can exist, but you’re not likely to see a child-sized tuba. Flutes are an exception, as they are made in a “child-sized” version by bending the long tube into a U shape. Rarely-seen alto flutes also are in a U shape.

[2]  Clients frequently come to me asking that I form an S corporation for them. Under state corporations law, both S corporations and C corporations are the same types of entities – a for-profit corporation (sometimes called a stock corporation). The S corporation/C corporation distinction is a distinction under tax law.  By default, a corporation will be a C corporation under federal and state tax law, but by making a timely election for S corporation treatment, the corporation can be taxed as a pass-through, S corporation.

This series draws from Elizabeth Whitman’s background in and passion for classical music to illustrate creative solutions for legal challenges experienced by businesses and real estate investors.